[BRIEF NOTE] On the prospects of Postmedia

[rfmcdonald]

Postmedia News is the largest shard of Conrad Black's once-mighty media empire, comprising some of Canada's most prominent newspapers (the National Post, Ottawa Citizen, Montreal Gazette, Calgary Herald, and so on). Traditionally privately held, Postmedia will soon be listing shares on the Toronto Stock Exchange. It's doing so oddly, though, as the Toronto Star's Josh Rubin points out.

The decision of the National Post’s parent company to list its shares on the Toronto Stock Exchange without an initial public offering is “highly unusual” and could indicate that the company had trouble finding an investment bank willing to underwrite an IPO, says a Queen’s University business professor.

Postmedia Network Canada Corp. filed a “non-offering prospectus” Tuesday.

In over two decades of studying the IPO market in Canada, professor Louis Gagnon said he can’t think of a similar manoeuvre.

“It tells me one of two things. That they approached underwriters and were told no, or that an underwriter expressed interest, then found they wouldn’t be able to sell the offering,” said Gagnon.

Postmedia spokesperson Phyllise Gelfand said the company is "happy with capital structure of the company and not looking to issue new shares at this time."

Postmedia was sold to a group of its unsecured creditors last summer for $1.047 billion.

One industry observer suggested the purchase agreement with creditors included a commitment to have Postmedia shares listed on the TSX by this July. The observer expects some kind of offering later this year, after the shares are listed.

The Globe and Mail's David Milstead and Susan Krashinsky suggest a lack of interest is indeed part of it. There's more.

Postmedia Network Canada Corp.’s decision to list its shares on the Toronto Stock Exchange was driven neither by a need to raise capital nor a desire to open up share ownership to the general public.

Instead, the company, owner of the National Post and 10 major metro newspapers across Canada, was motivated by the risk of losing its designation as a publisher of “Canadian newspapers” under the federal Tax Act. If Postmedia lost that status, the advertisers in its newspapers, big and small, could no longer deduct their ads as a business expense – a potentially crippling blow to the company.

The penalty “is basically, you have the advertising in your publication not eligible for a business expense,” Postmedia CEO Paul Godfrey said in an interview Thursday. “Which means not very many people would advertise – which is a pretty good penalty. Everybody would recoil on that.”

Postmedia warns investors in its prospectus filed earlier this week that if its newspapers cease to be “Canadian newspapers” for purposes of the Tax Act, it expects advertising revenue “will decline significantly.” That would have a “material” adverse effect on Postmedia’s financial condition, it says, employing the term used in securities law to describe a large effect of concern to investors.

The clock is ticking for Postmedia, which acquired the CanWest newspaper division out of bankruptcy in July, 2010. The deadline for establishing its tax status as a Canadian newspaper publisher is July 31, the end of the Tax Act’s one-year grace period.

The law provides a couple of ways for a company to qualify as a Canadian publisher. One is to show that at least 75 per cent of its shares are owned and controlled by Canadians. But since Postmedia is still owned primarily by U.S. hedge funds and banks involved in the CanWest bankruptcy, it would flunk that test.

So Postmedia is taking a second approach allowed by the Tax Act: It qualifies as a Canadian publisher if it lists on a Canadian stock exchange and is not “controlled” by non-Canadians, regardless of their economic ownership.

To pass muster, Postmedia created two classes of stock, voting and “variable voting” shares. The “variable voting” shares lose their voting power if they account for more than 49.9 per cent of the company.

And for the foreseeable future, they will indeed be powerless: Postmedia issued nearly 37 million variable voting shares, compared with just 3.7 million voting shares. The numbers suggest that non-Canadians currently own roughly 90 per cent of the company.

“It’s obviously easier to go public,” Mr. Godfrey said. “The share structure at work here has been used by several other organizations, where you have voting shares, which will be Canadians, and variable voting shares, which will be non-Canadians, with the voting shares always having 50.1 per cent of the votes on any given vote.”

The company has also adopted a poison pill that allows existing shareholders to buy stock at a 70 per cent discount if a new stockholder acquires 20 per cent or more of the company’s shares.

Were it not for the tax considerations, it seems Postmedia would not have done a listing in this way. No shares are being sold as part of the TSX listing, meaning none of the stockholders are cashing out of their investment as a result. And the company isn’t raising any capital.

In addition to being part of the wreckage of Black's erstwhile empire, Postmedia is hindered by the sorts of problems intrinsic to media conglomerates : "Most North American newspaper companies are showing year-over-year revenue declines, with Postmedia saying its revenue for the quarter ended Feb. 28 likely fell 4 to 5 per cent. In addition, Postmedia has significant debt and covenants that restrict the payment of common stock dividends. With $616.3-million of debt at Nov. 30 and EBITDA, or earnings before interest, taxes, depreciation and amortization, of $157.6-million in the fiscal year that ended in August, Postmedia has a debt-to-EBITDA ratio of nearly four to one."